Friday, 7th of August 2020
“When things go wrong, don’t go with them.”
– Elvis Presley
August has been a good month for equities so far. Ahead of the Friday market open, the S&P 500 Index is up +2.4% this week, following on from strong performance in July despite the Southern United States facing a major second wave of covid-19 and economic data suggesting that the US jobs recovery has slowed. Indeed, Florida now has >500k confirmed cases of the coronavirus, which, if it were a country, would make the Sunshine State the sixth worst effected globally (to the extent that official numbers give a rough guide as to the scale of the local outbreak). There is little doubt that the American experience of this pandemic has further to run, and the White House coronavirus task force head has warned of a dangerous ‘new phase’ of the pandemic as the virus spreads across urban and rural areas in equal measure. Nevertheless, many US companies have beat pessimistic analysts’ forecasts for Q2 earnings, while Big Tech names have soared as the ‘stay-at-home’ economy boosts online retail and accelerates adoption of new communications and cloud infrastructure.
The Euro Stoxx 600 Index is also positive this week, climbing +1.7% by Thursday’s close. Nevertheless, the pan-European benchmark has seen mixed performance in recent days and is down again on Friday morning. The risk-off mood has much to do with the increase in new cases in countries including Spain, France, and Germany, where officials have suggested that a second wave could force them to re-impose restrictions that have been eased since May. This could stifle the nascent economic recovery on the continent and wreck the finances of countries already burdened by massive sovereign debts. At the end of July, European governments agreed a EUR 750bn pan-EU recovery fund to much fanfare. This is the first countercyclical fiscal instrument at the disposal of the European Commission, and its agreement buoyed investors worried about EU fragmentation (and saw EUR outperforming most other currencies). However, the scale of the economic crisis sparked by the pandemic could yet cause bitter splits between member states about how to respond to spiralling debts and structural weaknesses in Southern Europe. We therefore continue to favour US equities, and the dollar, (for now) – even if some currency weakness now is hardly a surprise given the collapse of many EM currencies earlier this year.
The MSCI Emerging Market Index has also generated positive returns this week, up +2.6% (in USD). EM equities have been rocketing higher since the end of May despite large economies, such as Brazil and India, struggling to contain major outbreaks of the virus. Each has >1m confirmed cases, and both lack the healthcare infrastructure needed to handle the surge in infections. Cutting rates, as Brazil did this week to a record low of 2%, will do little to offset the economic carnage. Nevertheless, the Chinese recovery has been strong enough to drive the EM benchmark higher, with the CSI 300 Index composed of the most liquid Mainland stocks now up +16.6% for the year in dollar terms. Ironically, despite being the source of the virus, China is the only country that is still expected to grow this year according to the IMF. If true, this is remarkable. Although in the doldrums today, emerging markets remain a high conviction of ours for the years ahead. There is little doubt that those most hungry for a better life today will build many of the best companies tomorrow, and the more cyclical and commodity-dependent EM economies – hardest hit by collapsing energy prices and weak global demand this year – will be geared into the recovery when it comes in earnest. Asset-rich value stocks, which began to climb sharply in May and June, could yet have their day when a vaccine becomes more certain and the outlook improves.
Beyond the hunt for a vaccine (which Russia claims to be winning, without evidence), perhaps the most important risk for markets is the geopolitical tussle between the US and China. Both have sharpened their knives after the Mainland government imposed a controversial national security law on Hong Kong at the end of June, and there has been no attempt to soften the ensuing vitriol. Indeed, China appears to be adopting a more bellicose posture in the South China Sea and the Himalayas, while the US has called for what can only be described as a complete decoupling of Chinese and Western technological development. As the US election approaches, and with President Trump trailing former Vice President Biden in the polls, American foreign policy is likely to become more unpredictable. However, for now, the China hawks led by Secretary of State Mike Pompeo have the upper hand in the Administration, escalating tensions over human rights in Xinjiang, the crisis in Hong Kong, and China’s trade practices, while describing US-China relations in starkly hostile terms. (The decision to close China’s consulate in Houston for alleged espionage won’t be the last combative US move to cause uproar in China.) Whether a hawkish US policy towards China is the ‘new normal’ or a pre-election gambit to win over rustbelt states will only become clear in the new year. But it looks more and more like a bipartisan consensus in the US Congress. We suspect that a new Cold War is in the offing – or already underway. Today’s moves from the US to ban American companies from transacting with ByteDance, and restrictions on doing business with Tencent, only serve to underscore the above.
We continue to believe that geopolitical and economic events could trigger a near-term correction amid thin liquidity this summer. This is more likely to occur in equity than in credit since the Fed, ECB, and other central banks, have effectively put a floor under bond prices given the scale of asset purchases unleashed since mid-March. But with so much money in circulation (with a US savings rate that hit 23% in July!) and more fiscal and monetary cannons still in reserve, any big declines should quickly reverse. We thus see no reason to give up equity risk, while sizable cash and gold positions remain an option for portfolios. The yellow metal recently smashed through $2000/oz, a new all-time high, and we believe it has further to fly given the massive liquidity injections from central banks, and rates being at or below zero. Meanwhile, silver, which was up +34.9% in July, has continued to climb sharply this week, adding +15.8% by Thursday’s close, which arguably shows that a short-term correction is inevitable. However, the environment today – paralysing economic uncertainty, rising geopolitical tensions, massive QE and ultra-low rates, rich valuations in most asset markets, a boom in fiscal spending and sovereign debt, and, lately, a weakening dollar – could not be more bullish for precious metals.